The Standard is the marketing name for StanCorp Financial Group, Inc., and its subsidiaries. StanCorp Equities, Inc., member FINRA, wholesales a group annuity contract issued by Standard Insurance Company and a mutual fund trust platform for retirement plans. Standard Retirement Services, Inc. provides financial recordkeeping and plan administrative services. Investment advisory services are provided by StanCorp Investment Advisers, Inc., a registered investment advisor. StanCorp Equities, Inc., Standard Insurance Company, Standard Retirement Services, Inc., and StanCorp Investment Advisers, Inc., are subsidiaries of StanCorp Financial Group, Inc., and all are Oregon corporations.
IRS Issues Proposed Regulations for Hardship Distributions
In early November 2018, the IRS issued proposed regulations regarding hardship distributions for 401(k) and 403(b) plans. This new guidance primarily addresses hardship distribution recommendations made in the Bipartisan Budget Act of 2018. At the same time, it addresses related questions about hardship distributions that unexpectedly arose from the Tax Cuts and Jobs Act of 2017 and recent disaster relief guidance.
Clarification on Hardships for Home Casualty Loss
Before the Tax Act, a participant could take a hardship distribution for expenses to repair damage to the participant’s principal residence, if the damage qualified for a casualty loss deduction under Code Section 165. A seemingly unintended consequence of the Tax Act was that it eliminated the casualty loss deduction unless the loss was due to a federally-declared disaster. This change resulted in many participants being ineligible to take a hardship distribution if their homes were damaged for reasons other than federally-declared disasters. The new IRS guidance clarifies that a home casualty reason for hardship does not have to be in a federally declared disaster area, essentially restoring it to the pre-Tax Act standard.
Expanded Hardship Circumstances
Current IRS hardship distribution safe harbor regulations list six categories of hardship events in order for an employee to be considered to have an immediate and heavy financial need. The proposed regulations will add the following circumstances:
- Hardship distributions for qualifying medical, educational and funeral expenses will include those expenses incurred by a participant’s “primary beneficiary” under the plan. This is a modification to the previous regulations that referenced only a spouse or dependent.
- Under a new category of permitted hardship distribution events, participants could take a hardship distribution due to expenses and losses (including loss of income) incurred after federally-declared disasters, as long as the participant’s home or principal place of business at the time of the disaster was located in an area designated for federal assistance. This change would allow plans to offer immediate assistance to affected participants without having to wait for the IRS or Congress to take specific action in response to the particular disaster, as has been the case.
These changes generally apply for distributions made in post-2018 plan years; however, they may be applied to hardship distributions made on or after a date as early as Jan. 1, 2018. This allows plan sponsors to conform their plans retroactively to actual operational activity.
Elimination of Six-Month Contribution Suspension Requirement
Currently, participants who take a hardship distribution under the safe harbor rules are prohibited from making elective deferral contributions (including Roth deferrals) to the plan for six months. Many retirement plan experts have argued this “deferral suspension” rule unnecessarily prevents participants from continuing their retirement savings by cutting off not only the participant’s own contributions but any potential employer matching contributions. As directed by the Budget Act, the IRS proposed regulations that eliminate the six-month contribution suspension requirement. The elimination comes with some options for its application. It may be applied to hardship distributions made on or after Jan. 1, 2019, but is not mandatory until hardship distributions made on or after Jan. 1, 2020.
Expansion of Sources for Hardship Distributions
Consistent with the Budget Act, the proposed regulations expand the sources available for hardship distributions to include earnings on elective deferrals, QNECs, QMACs and earnings on QNECs and QMACs. The guidance also confirms that safe harbor 401(k) employer contributions (and earnings thereon) are also available sources for hardship distribution.
Plan sponsors would not be required to expand the available sources for hardship distributions. Instead, they could continue to limit the amounts available for hardship distributions consistent with the prior rules.
Special Consideration for 403(b) Plans: Under the proposed regulations, earnings on pre-tax deferrals made to a 403(b) plan continue to be ineligible for hardship distributions. However, QNECs and QMACs would be eligible for hardship distributions in a section 403(b) plan that is not in a custodial account. QNECs and QMACs in a section 403(b) plan that is held in a custodial account would continue to be ineligible for hardship distributions.
Another existing safe harbor rule to demonstrate that a requested hardship distribution is necessary is that the participant must take all plan loans otherwise available before taking the hardship distribution. Consistent with the Budget Act, the proposed regulations would remove this requirement effective for hardship distributions made on or after Jan. 1, 2019.
The new standard will be:
- The hardship may not exceed the amount of the need, adjusted for anticipated taxes and penalties.
- The participant must have obtained all other available distributions under the plan (excluding loans).
- The participant must represent that he has insufficient assets available to satisfy the financial need.
- The plan administrator may rely on the participant’s representations unless they have actual knowledge to the contrary.
Applicability Date and Deadline to Amend Plans
The proposed regulations generally apply to hardship distributions made in plan years starting after Dec. 31, 2018, unless an exception otherwise applies.
Special Note – Plan Amendment Required: Plans that permit hardship distributions will need to be amended to reflect these new hardship distribution rules once the regulations are finalized. These amendments would be treated as qualification requirement amendments and subject to an extended due date for plan amendments. The final date is to be determined; however, the general rule is that plans have until the end of the second calendar year beginning after the issuance of an IRS-issued “Required Amendments List” reflecting the new rules. That is the outside date for amendments, however. Plan sponsors should consider plan amendments well in advance of any final deadline.